Don’t Fear the Rater: Analyst Reactions to Moody’s Downgrade Threat

By Mark Gongloff

You’d think that, after a major rating agency warns it’s about to slap you with a credit-rating downgrade, you’d have to pay more to borrow money. And you’d be right, unless your name was Uncle Sam.

Ten-year Treasury yields are at 2.92% this morning, near their lows of the year, despite the warning from Moody’s last night that the US AAA bond rating was in peril if it doesn’t put the kibosh on this debt-ceiling debacle.

And little wonder, judging by the tone of several notes from economists and bond strategists this morning, who say the rating-agency cage-rattling is hardly the end of the world:

Goldman Sachs:

Moody’s decision today to put the US on review for possible downgrade was, in our view, well telegraphed and does not significantly increase the likelihood of a downgrade. While headlines have swung from reports of a $4 trillion package last week to concerns more recently that no agreement will be reached, the underlying situation hasn’t changed nearly as much. New details have emerged which support the view that near-term fiscal contraction would be modest. New “plan Bs” are emerging as to what to do if Congress fails to reach an agreement by the August 2 deadline, but the most likely means to a long-term debt limit increase remains the deficit reduction package that is being negotiated.

Jim Vogel, FTN Financial:

Unlike many aspects of credit analysis, the market is likely to render its own judgment on the US’s credit standing rather than register a knee-jerk response to any rating agency’s views on a topic of this magnitude. One reason is that rating agency cookbooks don’t function that well on large scale, complex issues. Investors are much more likely to follow rating wisdom when the issuer in question represents one segment of an industry or a smaller sovereign. Concluding the US political process is fundamentally flawed — when this particular government array has been at it five months — is a stretch few of the world’s most aggressive investors would be willing to make right now.

Although part of Moody’s message raises important issues about debt management going forward, the immediate focus on August raises the bar for Aaa that is a big stretch in this political environment. By requiring a high degree of political unity/speed on a genuinely contentious issue, Moody’s actually diminishes its own credibility and its standing to influence market behavior on global sovereign issues. S&P has taken a similar stance and runs the same risks among investors.

John Higgins, senior market economist at Capital Economics:

If a downgrade does occur, we doubt it will trigger widespread panic selling of Treasuries provided bondholders continue to get paid and the government does not default. Admittedly, the outcome might be very different if, in the unlikely event, the government actually defaults and this obliges some investors to liquidate their holdings of Treasuries for regulatory reasons. But even then, the impact might be short-lived and less than some fear, as the loss to bondholders would probably be small – presumably amounting to only a short delay in receiving their cash flows on Treasuries.

[P]rovided Congress can agree on a credible strategy for deficit reduction in the relatively near future (i.e. shortly after next year’s presidential election at the latest), we think investors’ faith in US government debt is unlikely to be shaken permanently. If a ratings downgrade galvanised Congress, it could even have a positive impact on Treasuries in the medium term.

Mike Schumacher, UBS rates strategist:

In our view, the chance of the US defaulting briefly if the political process goes off track is a risk that investors should not ignore. We continue to recommend buying 10yr Bunds vs. Treasuries, positioning for the long end of the US yield curve to steepen, and buying short-dated payer swaptions on the belly of the US curve versus selling shorter tenor payers.

Comments (5 of 8)

The government is running out of money to pay its obligations which include Social Security, repaying money that was borrowed through issuing bonds and other debts, and everything else the government spends money on. There's practically no time left to cut spending in order to pay current obligations. Raising the debt ceiling will allow the government to borrow money in order to pay its bills. If the debt ceiling isn't raised, money can't be borrowed, bills can't be paid, and obligations will be in default.

1:04 pm July 14, 2011

Dave wrote :

Sorry folks but I will sell my bond holdings on July 20th if there is no agreement in place. Congress needs at least 10 days to pass the law to raise the debt ceiling. I don't want to be in the ocean when the tsunami hits. I will follow PIMCO.

12:55 pm July 14, 2011

L Kaplan wrote :

The comments sound well reasoned and are without panic. This should remind us when we here expressions of panic that the person making it is not as sound and reasoned as they should be. The worst is to use fear as a reason to come to a particular agreement, not that one is adverse to the idea of coming to an agreement.

INo one has pointed out yet why not raising the debt ceiling necessarily leads to default on obligations.

12:14 pm July 14, 2011

Miser wrote :

Remember, these guys are always wrong.
Analysts never get it right...They just guess like we all do.

12:09 pm July 14, 2011

Really Nervous wrote :

Well Europe will certainly be happy to hear that investors are now ready to ignore the advice of the credit raters. Does this mean the markets are ready to make another blissfully ignorant push into new highs? I'm sure Bernankenstein and Jihad Obama would love to see that...

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